Spread betting can be quite complex, our expert advisor Andrew Mackenzie from Spreadex explains what to be aware of when trading a spread betting account.
If you didn’t know your FTSE from your footy six months ago, you’ve no excuse now.
The escalation of the global financial crisis and the knock-on effects to the British economy mean that the crashing world markets are now regularly front page news in the UK.
And the undulating nature of indices such as the FTSE, the Dow Jones, the DAX and the Nikkei have arguably never seen so much attention.
This volatile situation – while a serious concern for those who have invested in traditional shares – is a spread better’s dream.
However, it is vital that trades are executed with care and with a strategy in place to avoid potential huge winnings turning into big losses.
The concept of spread betting is based on benefiting from the movements of global shares or world markets by either ‘buying’ or ‘selling’ an interest in those fluctuations (see previous article ‘The Shorts and Longs of Spread Betting’ for a full description of the workings of spread betting).
So for anyone with spread bets on the FTSE 100, the wild movements may often represent much more than just an indication of the share performance of Britain’s top 100 companies.
The beauty of spread betting as an investment tool is that – done well – traders can profit from movements up or down and, currently, winnings are tax free.
Investors can also take advantage of the low cost of entry with spread betting on indices starting from as little as a £1 stake per point movement.
But what is the best way to jump on the spread betting bandwagon?
Well, essential to the armoury of the spread better and the first thing to understand is the notion of ‘stops’ and ‘limits’ – procedures which allow traders to dictate market levels that they wish to either trigger profits or to control losses.
‘Stops’ give you confidence in your positions by ensuring that, if the markets were to move against your predictions, you can never lose more than a nominated amount or level.
The danger exists that sudden or overnight market drops or rises can cause levels to ‘gap through’ stop orders resulting in losses larger than accounted for.
These can be avoided by ‘guaranteeing’ your stops.
Traditionally ‘guaranteeing’ stops has incurred a premium or charge from companies who would have to take the loss on your behalf should the market move suddenly.
However, the introduction of completely free – and also mandatory – guaranteed stops from new spread betting firm ShortsandLongs.com has redefined the rules of spread betting, making it potentially more attractive as an investment tool.
‘Limits’ act in the opposite way to stops and work by closing out your trades for a nominated level of profit should the market reach a certain point.
The idea of ‘limiting your winnings’ may sound strange to some. But the idea is that traders will usually have a hunch that markets may rally to a certain level before dropping, so will nominate their predicted market high as the point to take their profits before a slump.
They are also particularly useful for people who aren’t able to monitor their bets throughout the day in order to manually close out certain positions at required levels.
So how do ‘stops’ and ‘limits’ work in practice?
Well, let’s say you had been looking to make a short-term spread bet on the FTSE 100 on Friday, October
24.
With GDP figures due to be announced later in the day and with the expectation being that figures would show a contraction of the ecomony, you decide to ‘sell’ at a quote of 3879 for a stake size of £2 per point movement just after the opening at 8am.
You set your ‘stop’ at 3940 meaning your trade would be closed should the FTSE rise to that level meaning you would lose £122 in a worst case scenario (3940 - 3879 = 61 x 2 = £122).
You choose not to place a ‘limit’ instead deciding to monitor the FTSE after the GDP figures are announced.
After placing your bet the FTSE rises close to your ‘stop’ reaching 3,937 at about 9am before falling.
The index then plunges downwards as speculation mounts over the potential negative impact of the expected GDP figures.
At 10am the FTSE is at 3,850 and then drops further hitting 3,720 before rising slightly to 3,729 at 11am.
You decide to keep your trade open with the belief that the FTSE will fall further. Instead the index rises to 3,812 by noon and you close out your bet for a profit of £134 (3,879 - 3,812 = 67 x 2 = 134).
The above scenario shows how placing ‘stops’ or ‘limits’ at different levels can affect your profits or losses.
For example if you had set your initial ‘stop’ at 3,920 you would have been closed out for a loss of £82 (3920 - 3,879 = 41 x 2 = 82) missing out on your potential profit.
But also, if you had closed out at 3,720 you would have made £318 (3,879 - 3,720 = 159 x 2 = 318).
Of course if you had set a larger or smaller stake size winnings or losses would have been multiplied. Also the fluctuations through the morning show how bets would have been affected by the movements should they have been placed at different times.
The above example represents a bet over a very short time period and, of course, spread betting can be used as investment over a much longer term.
But even so it highlights the thrill and excitement offered by this fast-growing form of trading – where the same possibilities of profits and losses exist in betting on the movement in a variety of markets from oil or gold to currencies or bonds.
LINKS
www.spreadex.com
Andrew MacKenzie worked for eight years as a journalist covering news, business and sport across a variety of titles including The Sunday Times, The Telegraph, The Mail on Sunday and The Daily Mail online. He has been PR Manager at Spreadex since November 2007
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